Copyright 2013 Tom Madell, PhD, Publisher
May 2013

A Brief Review of Our Model Portfolio from One Year Ago and What It Suggests Looking Forward

By Tom Madell

In our April '12 Model Portfolios, we recommended our highest allocation to stocks for Moderate Risk investors going all the way back to April 2002. That allocation, at 67.5% of one's entire portfolio, approached nearly 3 times our bond allocation of 27.5%. Additionally, we recommended an 85% allocation for Aggressive investors and a 45% one for Conservative investors, the latter recommendation being the first time we recommended more stocks than bonds for highly risk-averse readers.

So how would have adhering to such relatively high allocations turned out? Over the following 12 months, the S&P 500 index has returned close to 3 times the amount (14.0%) as has the fund which most use as a bond benchmark, Barclays Aggregate bond index (AGG) (3.8%). (Note: Data mentioned in this article are through March 31, 2013.) But let's focus on some of the particulars of what has happened since April 2012 to see what they might suggest for investors going forward.

Stock Fund Choices

We had expected large cap stock funds to outperform small and mid-cap funds. But over the period, smaller stocks remained ahead by a small amount. The exceptions have been that small-cap and mid-cap growth underperformed large blend and large value, although not large growth.

What this suggests is that large caps are even more undervalued today vis-a-vis funds focused on smaller capitalizations. We continue to highly favor them in spite of the fact many investors keep pushing smaller caps higher and higher. The Russell 2000 small cap index has been regularly breaking its record highs, initially in mid-Sept. last year and since the beginning of this year.

In fact, the Russell 2000 index has gone up close to three-fold since reaching its bear market low in Mar. '09. And since the start of 2000, the index is up nearly 90%, while the S&P is up only about 8% (neither figure annualized nor including dividends). Such a comparison is stark, to say the least, and suggests that small caps have been pushed up way out of proportion to less risky large caps. While small caps may continue to outperform even longer, we see much better long-term prospects for the large caps going forward.

The S&P 500 finally surpassed its previous Oct. 2007 record high just recently in late March. But, of course, this means that, excluding dividends, it has only gotten back to where it was approximately 5 1/2 years ago. The Dow Industrial Industrial Average which too consists of large cap stocks did also just recently pass its record high from Oct. 2007 in early March. But adjusted for inflation, the Industrial Average is far from a record: It hasn't been in real, inflation adjusted record territory in more than 13 years, which again shows that many investors have not made out well at all in the large cap area, and that therefore, are a much more undervalued category for investors than small caps. (Please see the May 2012 Newsletter if you wish to review our earlier discussion of additional data on why we think large caps should outperform.)

Our Remaining April '12 Recommendations Were Highly Successful and Remain Valid

We also strongly recommended an international fund, Tweedy, Browne Global Value (TBGVX), that would not suffer due to US dollar strength, a trend we saw as likely continuing since reaching a multi-year dollar low point around mid-2011. As it turned out, the dollar has indeed continued to rise. This helped contribute to why TBGVX beat out most other types of international stock funds by over 8% during the period, returning 17.5% vs. only 9.3% for the average international fund. Making the decision to invest in TBGVX instead of the typical "unhedged" fund, such as Vanguard International Growth (VWIGX) would have alone added about 2% to a portfolio's return at the allocation level we recommended.

Also noteworthy both in terms of our prior Apr. '12 stock recommendations were the following:

Although more than a full year later now, we think all of these choices remain valid choices today as is reflected in our current Apr' 13 Model Stock Portfolio.

Bond Fund Choices

Our Apr. '12 Model Bond Portfolio returned approximately double the return on the AGG index, the latter returning 3.8% for the 12 mo. period. The outperformance was exactly along the lines we had predicted a year ago, with the biggest gains as we had anticipated in high yield, multisector, and corporate categories. Our newly selected fund, Loomis Sayles Retail Bond (LSBRX), continued its admirable prior performance. And our choice for an international bond fund, PIMCO Foreign Bond (USD-Hedged) Adm (PFRAX) which, like TBGVX above, would not sustain losses due to the strong dollar was also a big plus. But worthy of mentioning too was our continued large allocation to PIMCO Total Return Instit (PTTRX) or Harbor Bond Fund (HABDX), both managed by Bill Gross. They both did even better than we had expected. The same is true for our two inflation-protected bond funds, also managed by a PIMCO manager. Our very small commitment to US government bonds and GNMA funds enabled us to mostly avoid the poorest performing bond categories.

Most of these choices remain valid today, although now we are tending to avoid US government bonds and GNMA funds altogether and instead substituting foreign bonds, which seem to offer better prospects.

So What Can Be Learned from Reviewing These Results?

At times, feedback has suggested some readers would prefer that I devote nearly all of my newsletter content to what I am now recommending looking ahead, and perhaps less or none at all to my prior recommendations. After all, what happened with my Model Portfolios in the past doesn't appear to help a current reader one iota, only what's still possible going forward. However, I continue to think that a look at these prior results may be just as important, or even more so, than my new Model Portfolios themselves.

It should be noted that one of the first things I like to emphasize is that I try to avoid making global appraisals as to whether or not the period ahead is likely be a good time to be invested in stocks or bonds in general. Rather, what I mostly focus on is which specific funds, and in some cases, which categories of funds will be the best places to invest in no matter how the overall stock and bond markets might do. If I am correct in this assumption, then choice of these particular funds (especially stock funds) will quite often wind up doing better than the typical fund in their category. And my Stock Model Portfolios going back to the year 2000 show that these portfolios have typically done better than the S&P 500 index, although the outperformance has suffered during the last 4-5 years as a result of the fact that international funds have generally lagged the US-only index.

As suggested in the results above, the inclusion (or exclusion) of even one or two of my specifically emphasized funds such as TBGVX or PTTRX could have a significant bearing on one's overall results. So investors who tend to focus most or all of their attention on just the overall market itself may be missing out on what my Newsletters have been proven to be best at - that is, giving investors some specific fund choices that are worth the effort of getting into, as opposed to "standing pat" with a fund they may have started with and are perhaps remaining in and for perhaps not the best of reasons. (Note: However, as pointed out in the April Newsletter, if you are already invested in a comparable fund to one that I recommend and are satisfied with the results thus far, then treat my suggestions as just that.)

By presenting past Model Portfolio results, I am attempting to: a) diminish some of the skepticism that people, including myself, often experience when they encounter free (or really any) investment advice; b) instill confidence that individual investors can indeed successfully navigate the myriad of choices when it comes to investing; and c) demonstrate that investors who followed some or many of the recommendations found in the Newsletter likely achieved better results than if they hadn't.

While taking a somewhat more active approach to investing as is generally advocated here definitely requires some extra work, and entails, perhaps, taking a small degree of extra risk as compared to not acting, I firmly believe that those who choose to do so will be more than adequately rewarded.

Research has repeatedly shown that most investors in funds do not achieve the kinds of returns that would be considered "good" in any respect. For example, considering investor experience between 1992 and 2011, it was recently reported that the average return for investors was a mere 2.1% across all types of stock and bond funds. The 2.1% figure for the average investor comes from long-term research showing average investor return, which utilizes actual data on mutual fund sales, redemptions and exchanges each month as a measure of what investors wind up with as a result. (Note: Interested readers may want to refer to this article which elaborates on this data.)

Additionally, even more recent data as published in the New York Times (available here) shows that over the last 20 years investors U.S. stock mutual funds only earned an average annualized return of 4.25 percent during that period, while the Standard & Poor's 500 stock index generated an 8.21 percent return.

In this universe of many mediocre returns, investors willing to carefully study our suggestions as well as past results, can reasonably expect to have a leg up.


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